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Surrender control of 401(k)?

By Barbara Whelehan ·
Friday, July 8, 2011
Posted: 3 pm ET

Automatic enrollment of workers in 401(k) plans may be backfiring, according to an article in yesterday's Wall Street Journal. Citing an analysis performed by the Employee Benefit Research Institute, the Journal found that 40 percent of new employees are contributing less to their plans than they otherwise would if they had signed up on their own.

A provision in the Pension Protection Act of 2006 allows companies to automatically enroll their employees in a company retirement plan to help workers prone to inertia. The pension law includes related provisions, such as an automatic escalation feature that enables employers to increase employee contributions annually. And employers are relieved of liability for allocating the employee contributions to qualified default investment alternatives -- such as balanced funds or target-date funds.

The problem: More than two-thirds of companies set initial contribution rates at 3 percent of salary or less. And the automatic escalation feature typically bumps up the contribution rate by 1 percentage point annually up to a limit in subsequent years. Most experts say people should contribute at least up to the company match, and the more you contribute, the better. Conventional wisdom calls for contributing somewhere between 10 percent and 15 percent to adequately prepare for retirement.

For its part, EBRI blogged that the WSJ glossed over the fact that automatic enrollment is "increasing savings for many more (people) -- especially the lowest-income 401(k) participants."

The law of good intentions

As I mentioned in a column five years ago, "Pension law: Many changes, mostly positive," shortly after the pension law was enacted, automatic enrollment is a good thing because Americans will be better prepared for their retirements even if they don't give it much thought. We tend to be ruled by the force of inertia, and it requires great psychological effort, apparently, to sign up for a retirement plan, judging from the increase in participation rates since the law went into effect.

But we can overcome that force and opt out of the plan if necessary. Or better yet, we can override automated features manually by increasing our contribution rate if we take control of our retirement plan. Bankrate plans to launch a special package on Monday that focuses on how to take charge of your 401(k) -- so look for it.

Is a retirement-related default mechanism sanctioned by the government always a good idea?

A new report released by the Government Accountability Office last week analyzes what happens on the other end of the retirement planning spectrum -- the decumulation phase, as it's known in industry jargon. Called "Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices," the 72-page report examines the complicated issues inherent in converting retirement savings into income that lasts through retirement. The report is a fascinating read; I highly recommend it for anyone age 55 to 70 who doesn't have their retirement income plan all mapped out yet. Read it at the beach!

But a recurring theme of the report is the worrisome trend that few workers (6.1 percent) convert their 401(k) money into an annuity. So the GAO came up with some ideas to promote adoption of annuities, including one policy proposal that scares the heck out of me:

"Sponsors would be encouraged to offer an annuity as the participant's election by default in DC (defined contribution) plans. For example, some industry groups suggested that Labor clarify its regulation on qualified default investment alternatives (QDIA) regarding the conditions under which sponsors could include annuities as QDIAs. Another option for DC plans would require an annuity as the default way to take pension benefits, as with DB plans." (Italics are mine.)

I don't know about you, but I think this is a horrendous idea. If an employer wants to offer an annuity as an option, that's fine. But to make it the default option would be presumptuous and paternalistic, to put it nicely. I would prefer to muddle through money management rather than let others make these decisions for me.

To be fair, the GAO report offers discussion about the drawbacks of this proposal, which include greater costs and administrative burdens for the employer, and the possibility that the annuity provider may not be able to meet its financial obligations. Also, decisions concerning annuities tend to be irreversible or come with heavy penalties if you can reverse them.

I don't want to surrender control of my 401(k) plan, thank you very much.

What about you? Would you want your company to automatically put your 401(k) proceeds in an annuity?


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Patrick McGill
August 18, 2011 at 8:52 am

Annuities blow 401K's away. Check into Index annuities, their benefits which are guaranteed via some of the world's largest financial instituions are safe against market downturns, have lower fees and will double/triple your retirement funds in half the time of a 401K. Quit sending youe money to Wall Street, those Fat-Cats are eating off your table everyday, wake up! Check it out.

Mary Neville
July 11, 2011 at 12:09 pm

My 401K is mine, and I not someone else is the one who has the right to decide how and when I should receive it and in what form. People's money requirements are PERSONAL, and although an annuity might we correct for some, for others it would be a big mistake!

The GOA needs to stay out of my disbusement process, If I can gain more retirement usable dollars by paying cash for the balance of my mortage, or for a home repair, it sure beats paying interest and a payment to accomplish the same thing.

Let the GOA recommend a counseling session or two with an INDEPENDANT fee only financial advisor, and then let the person make their decision. THAT would be helpful.

Barbara Whelehan
July 10, 2011 at 1:38 pm

Hi Mike -- I'm guessing that it would be possible to opt out of this arrangement as can be done with current default mechanisms such as automatic enrollment and escalation. But plan participants who aren't paying close attention could end up with an annuity since that would be the default option, according to the proposal outlined in the GAO report. In that event they would be obliviously surrendering control of their 401(k). But let's hope the proposal doesn't get adopted to begin with.

Mike Murray
July 10, 2011 at 11:04 am

How does making an immediate annuity the default option force anyone to "surrender control" of their 401(k)? Nobody has to take the default.